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Vanderbilt: Transforming a Health Care Delivery System Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Vanderbilt: Transforming a Health Care Delivery System case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Vanderbilt: Transforming a Health Care Delivery System case study is a Harvard Business School (HBR) case study written by Michael E. Porter, Zachary C. Landman, Derek Haas. The Vanderbilt: Transforming a Health Care Delivery System (referred as “Vanderbilt Vumc” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Competitive strategy, Health.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment




Case Description of Vanderbilt: Transforming a Health Care Delivery System Case Study


In 2013, Vanderbilt University Medical Center was the top ranked hospital in Tennessee by U.S. News and World Report, and among the leading academic medical centers in the entire southeast region. The 2012 US News & World Report hospital rankings listed Vanderbilt's care for kidney transplant (11th), women's health (16th), heart (25th), and cancer (29th) as among the best in the nation. Its $292 million in National Institutes of Health research grants ranked ninth in the nation. Over the previous decade, the medical center had grown revenues, more than tripled its operating margin, and was operating at capacity in many areas, with average inpatient bed occupancy approaching 90 percent, versus the national average of 68 percent. Despite its growth, Vanderbilt University Medical Center (VUMC) was facing a revenue shortfall of $250 million over the next two years, as more patients shifted to lower reimbursement Medicare coverage and there were rising price pressures from commercial insurers, employers, and individual consumers. Dr. Jeffrey Balser, CEO of the VUMC, had to address the shortfall while maintaining the quality of patient care, education, and medical research.


Case Authors : Michael E. Porter, Zachary C. Landman, Derek Haas

Topic : Leadership & Managing People

Related Areas : Competitive strategy, Health




Calculating Net Present Value (NPV) at 6% for Vanderbilt: Transforming a Health Care Delivery System Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10018077) -10018077 - -
Year 1 3448782 -6569295 3448782 0.9434 3253568
Year 2 3977107 -2592188 7425889 0.89 3539611
Year 3 3953120 1360932 11379009 0.8396 3319116
Year 4 3227455 4588387 14606464 0.7921 2556447
TOTAL 14606464 12668741


The Net Present Value at 6% discount rate is 2650664

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting


What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.




Capital Budgeting Approaches

Methods of Capital Budgeting


There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Net Present Value
2. Profitability Index
3. Payback Period
4. Internal Rate of Return

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Vanderbilt Vumc shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Vanderbilt Vumc have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of Vanderbilt: Transforming a Health Care Delivery System

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Leadership & Managing People Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Vanderbilt Vumc often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Vanderbilt Vumc needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 15 %
Discounted
Cash Flows
Year 0 (10018077) -10018077 - -
Year 1 3448782 -6569295 3448782 0.8696 2998941
Year 2 3977107 -2592188 7425889 0.7561 3007264
Year 3 3953120 1360932 11379009 0.6575 2599241
Year 4 3227455 4588387 14606464 0.5718 1845308
TOTAL 10450754


The Net NPV after 4 years is 432677

(10450754 - 10018077 )






Calculating Net Present Value (NPV) at 20%


If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 20 %
Discounted
Cash Flows
Year 0 (10018077) -10018077 - -
Year 1 3448782 -6569295 3448782 0.8333 2873985
Year 2 3977107 -2592188 7425889 0.6944 2761880
Year 3 3953120 1360932 11379009 0.5787 2287685
Year 4 3227455 4588387 14606464 0.4823 1556450
TOTAL 9480000


The Net NPV after 4 years is -538077

At 20% discount rate the NPV is negative (9480000 - 10018077 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Vanderbilt Vumc to discount cash flow at lower discount rates such as 15%.



Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Vanderbilt Vumc has a NPV value higher than Zero then finance managers at Vanderbilt Vumc can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Vanderbilt Vumc, then the stock price of the Vanderbilt Vumc should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Vanderbilt Vumc should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Understanding of risks involved in the project.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.




References & Further Readings

Michael E. Porter, Zachary C. Landman, Derek Haas (2018), "Vanderbilt: Transforming a Health Care Delivery System Harvard Business Review Case Study. Published by HBR Publications.